Grabbing the bullion by the horns

Gold: A barbarous relic, as Keynes famously quipped, or the cornerstone of the financial system throughout history? The investor and author Peter Bernstein argues for the latter view in
The Power of Gold. The book is not really a global history of gold and its miners, refiners, hoarders and jewellers. Rather, it is a history of Western money dressed in gilded robes.

Gold: A barbarous relic, as Keynes famously quipped, or the cornerstone of the financial system throughout history? The investor and author Peter Bernstein argues for the latter view in
The Power of Gold. The book is not really a global history of gold and its miners, refiners, hoarders and jewellers. Rather, it is a history of Western money dressed in gilded robes.

The first half is a collection of vignettes from various eras: Egyptian, Greek, Roman, Byzantine, Islamic, medieval and early modern. The readable stories are mostly meant to illustrate Bernstein's conclusion that hoarding gold often has perverse effects. The historical progression becomes more interesting when it covers the European voyages of discovery and the effects of the New World's gold and silver on Europe.

Bernstein shifts rapidly from one topic to another, from the rise of credit in Europe, to Asian uses for gold, to a detailed chapter on the Royal Mint under Sir Isaac Newton. The solitary chapter on Asia only serves to highlight Bernstein's relative neglect of non-Western societies. Missing, for example, are China's stubborn clinging to the silver standard, the history of Indian gold smuggling, and the role of gold mining in South Africa.

It is as a history of money that the second half of the book comes alive. Bernstein clearly explains the creation of the gold standard in the early 19th century, the discoveries in Australia, California and South Africa, William Jennings Bryan's campaign against gold in the US, and the effects of the First World War and the Depression.

The twin themes are that politicians and bankers alike trusted gold to be the ultimate security for national currencies, and that the US dollar supplanted, but did not fully replace, gold after 1945. When Nixon shut the US Treasury's gold window in 1971, gold largely ceased to be a monetary asset. Discretionary policy-making by politicians and central bankers replaced the cold logic of the gold standard, which forced overheated economies into recession as their gold hoards dried up.

Bernstein suggests that, like gold, the dollar's role cannot last. He is sceptical of the homage paid to Alan Greenspan of the US Federal Reserve, and the perception that "the dollar has ruled the roost not just because of America's stunning economic power but also because of the extraordinary skill of the money managers at the helm of the American central bank."

Yet Benjamin Disraeli may have been correct when he said that the gold standard was the consequence, not the cause, of Britain's prosperity. Following Disraeli, Bernstein argues that the central bankers "looked good during the 1980s and 1990s because the basic economic conditions of those years made them look good... The inflationary impulses that stemmed from the welfare state had been stifled - no overwhelming force had come along to test the true skills of the central bankers or to rock the dollar from its perch."

Unfortunately, he does not address what gold's role in today's financial system ought to, or will be. Gold is often dismissed because it has proved a poor investment. Just because private investors avoid it, though, does not mean that central banks and multilateral institutions such as the IMF can afford to ignore it. There remains an incontrovertible reason for them to hold gold. It is the only monetary asset that is no one else's liability. Gold is immune from financial crashes, political crises, inflation or repudiation. For this reason alone, central banks do well to hold between 15 and 25 per cent of their foreign reserves in gold.

Central banks and other financial institutions simply own too much gold for them to be able to sell without incurring huge losses. Official gold holders might improve the usefulness of their metal reserves through greater use of gold lending (earning interest income) and by cooperating in off-market sales between official participants which will not disrupt the private market. Whatever the future of gold, readers with an interest in history or finance will welcome Bernstein's interesting, if selective, history of gold and money in the West.